LOS ANGELES -- The untimely disappearance of Sally Marrari's medical coverage goes a long way toward explaining why insurance companies are cast as the villain in the health-care reform drama.

"They said I never mentioned I had a back problem," said Marrari, 52, whose coverage with Blue Cross was abruptly canceled in 2006 after a thyroid disorder, fluid in the heart and lupus were diagnosed.That left the Los Angeles woman with $25,000 in medical bills and the stigma of the company's claim that she had committed fraud by not listing on a health questionnaire "preexisting conditions" Marrari said she did not know she had.

By the time she filed a lawsuit in 2008, she also got a diagnosis of pancreatic cancer and her debts had swelled beyond $200,000. She was able to see a specialist by trading office visits for work on the doctor's 1969 Porsche at the garage she owns with her husband.

"I've had about 10 visits," Marrari said of the barter arrangement that has proved more reliable than her insurance. "The car needs a lot of work."

Rescission -- the technical term for canceling coverage on grounds that the company was misled -- is often considered among the most offensive practices in an insurance industry that already suffers from a distinct lack of popularity among the American public. Tales of cancellations have fueled outrage among regulators, analysts, doctors and, not least, plaintiffs' lawyers, who describe insurers as too eager to shed patients to widen profits.

Those sentiments have become central to the health-care debate, as President Obama tries to tap into dissatisfaction with the insurance industry to build support for reform efforts. Each of the bills pending in Congress would prevent insurers from rejecting clients because of preexisting conditions.

No one claims to know how often policies are canceled -- in large part, congressional investigators say, because insurance companies are regulated by a patchwork of state laws and policies. But the practice is common enough to spur lawsuits and state regulatory action.

In the past 18 months, California's five largest insurers paid almost $19 million in fines for marooning policyholders who had fallen ill. That includes a $1 million fine against Health Net, which admitted offering bonuses to employees for finding reasons to cancel policies, according to company documents released in court.

"This is probably the most egregious of examples of health insurers using their power and their resources to deny benefits to people who are most in need of care," said Gerald Kominski, associate director of the Center for Health Policy Research at the University of California at Los Angeles. "It's really a horrendous activity on the part of the insurers."

Insurance company officials say they need to be able to cancel policies to control fraud, which by some estimates reaches $100 billion annually.

"We do not rescind a policyholder's coverage because someone on the policy gets sick," said Peggy Hinz, a spokeswoman for Anthem Blue Cross, a subsidiary of WellPoint. "We have put in place a thorough process with multiple steps to ensure that we are as fair and as accurate as we can be in making these difficult decisions."

Much of that process was a condition of settlements with state overseers, who fined Blue Cross $11 million over the past two years and required it, and all other major insurers in California, to restore canceled policies. Insurers still face court challenges, including a class-action suit targeting Blue Cross on behalf of 6,000 canceled policyholders.

"These cases are very, very good in front of a jury," said Bill Shernoff, whose Claremont law firm has settled 90 cases and has 130 cases pending. "I wish I could tell you the amount of money they throw at us just to make it go away and keep quiet."

In the only case to go to trial in California, an arbitration judge awarded $9 million to a beautician who had to stop chemotherapy for her breast cancer after Health Net dropped her policy. Company officials declined to comment.

In a pending case, Blue Shield searched in vain for an inconsistency in the health records of the wife of a dairy farmer after she filed a claim for emergency gallbladder surgery, according to attorneys for the family. Turning to her husband's questionnaire, the company discovered he had not mentioned his high cholesterol and dropped them both. Blue Shield officials said they would not comment on a pending case.

Officials from three insurance companies told a House Energy and Commerce subcommittee this summer they had saved $300 million by canceling about 20,000 policies over five years.

Critics charge that companies, rather than vetting applicants, wait until a claim is filed. "It only happens if you create this bill. Then they go back into your application," said Dev GnanaDev, president of the California Medical Association, which lobbied Democratic House leaders to include restrictions on cancellations in their legislation. "Costco doesn't let me take something back after 90 days," he said. "If they want to investigate, let them do it within 90 days."

Regulators say many omissions appear to be honest mistakes on forms that are needlessly complex. Others result from ambiguous conversations between patient and doctor.

Yvette Thomassian of Glendale, Calif., lost her Blue Cross policy because she did not declare a deviated septum. She questioned why a common misalignment of the nostrils would disqualify anyone but emphasized that her doctor never clearly indicated she had the condition. They spoke Armenian in the exam room, she said, where the physician's words were "You have a bone in your nose."

"It's been three years of hell," said Thomassian, whose suit over the $31,000 in bills is scheduled for trial in January. Blue Cross officials said they would not discuss specific cases.

For Teresa Dietrich, it was fibroids. The Northern California real estate agent was left to pay $19,000 after Blue Cross said she did not disclose a diagnosis of the benign uterine tumors. But Dietrich said the doctor who had written "fibroids" on her medical record never mentioned his suspicions to her. The bills destroyed her credit and cost her her home -- and, in a comically cruel twist, the surgery proved the doctor was wrong.
"They said I had a condition I didn't even have," Dietrich said. "And they canceled me."

If federal health-care reform bars companies from screening for preexisting conditions, insurers note that cancellations will no longer be an issue. But Melinda Beeuwkes Buntin, an economist at the Rand Corp., said that unless for-profit companies are compensated for taking higher-risk patients, the firms will continue to look for ways to unload them.

"They wouldn't be able to overtly kick you out, but that doesn't mean that they might not put, for example, more onerous preauthorization requirements on services that people who are at risk might need, and that might discourage you from re-enrolling next year," Buntin said.

She said one solution would be for Washington to subsidize insurers that take on higher-risk patients. The government does such "risk adjustment" for the private insurance provided through Medicare Advantage -- though Obama has called for ending those subsidies to finance reform.

"You can ban rescission," Buntin said, "but what we really want is a system under which insurers' incentives are aligned with treating all of their patients well, whether they're sick or healthy."

But hey, the invisible hand of the market is going to be enough to drive down costs right?

Oh wait. Like I said before, these companies are not in true competition with each other. It's more like they're following the rules set down by the Nash equilibrium. You don't need to socialize it but you need to get rid of rescission, you need to give everyone access to it and you need to have accountability.

There is more than one company giving promotions based on rejection (see statements before Congress 1996) and the minimum rejection rate at this companies is 10% with a preferred 15-20% rate when possible for individual agents. So these companies can go to hell for the way they run themselves.